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When close to half the companies in the United Kingdom have price-to-earnings ratios (or "P/E's") below 16x, you may consider Distil Plc (LON:DIS) as a stock to avoid entirely with its 27.3x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
Distil certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
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Does Growth Match The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as Distil's is when the company's growth is on track to outshine the market decidedly.
If we review the last year of earnings growth, the company posted a terrific increase of 60%. Pleasingly, EPS has also lifted 2,465% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.
In contrast to the company, the rest of the market is expected to decline by 1.6% over the next year, which puts the company's recent medium-term positive growth rates in a good light for now.
In light of this, it's understandable that Distil's P/E sits above the majority of other companies. Investors are willing to pay more for a stock they hope will buck the trend of the broader market going backwards. Nonetheless, with most other businesses facing an uphill battle, staying on its current earnings path is no certainty.
What We Can Learn From Distil's P/E?
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
As we suspected, our examination of Distil revealed its growing earnings over the medium-term are contributing to its high P/E, given the market is set to shrink. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. We still remain cautious about the company's ability to stay its recent course and swim against the current of the broader market turmoil. Otherwise, it's hard to see the share price falling strongly in the near future if its earnings performance persists.